Drawings are the amount of cash or goods withdrawn by the proprietor from the business for his/her personal use. However, frequent or excessive withdrawals from the business by the proprietor may adversely affect its working conditions. So, in order to discourage these frequent or excessive withdrawals, the business generally charges interest on the amounts so withdrawn. Such interest charged is known as interest on drawings. It is a gain for the business.
When Interest on Drawings is given outside the Trial Balance
Treatment of interest on drawings in the final accounts is as follows.
Firstly, interest in drawings is shown on the credit side of the Profit and Loss Account.
Secondly, it is deducted from the amount of capital on the Liabilities side of the Balance Sheet.
When Interest on Drawings is given Inside the Trial Balance
There may be a situation when interest in drawings is given inside the Trial Balance. In such a case, capital in the Trial Balance is already shown after deducting such interest on drawings. Therefore, there is no need to deduct this interest from the capital in the Balance Sheet and is shown only on the credit side of the Profit and Loss Account.
Operating Profit can be defined as the profit earned by carrying the normal business activities. It is computed by subtracting the operating expenses from the gross profit.
The balance sheet is the last financial statement that is prepared by any organization. This statement helps to ascertain the true financial position of an enterprise at the end of an accounting period
A profit and Loss Account is the second financial statement prepared by an organization. This account is prepared to ascertain the net results of a firm in form of net profit earned or net loss incurred during an accounting period.
In order to incorporate adjustments in the financial statements, we pass the required Journal entries, which are termed as adjusting entries.